Foreign Partners Still Control Branding in China R&D and Lineups

Jenny Gu

Soaring demand for luxury vehicles in China has seen many premium brands make the country their second home. Land Rover may be the next premium brand to begin local production, following on the path taken by Audi, BMW and Mercedes-Benz. Even automakers without a strong foothold in China are increasingly eyeing the country as a key engine for future growth.

Localized Production is Key to Success in China Market

Automakers need to localize in order to truly establish themselves in this market. As some global automakers and their local partners are busy ramping up production of localized luxury models, many other foreign carmakers are seeking Chinese partners, as is required by the government, to set up new joint ventures. Lexus, Infiniti and Land Rover are among those considering localization in China in the near future.

Localization made slow progress before 2009. Between 2005 and 2009, the number of luxury models produced in China rose from just eight to nine. However, in 2010, the number of luxury models that were locally produced climbed to 11, and is expected to reach 15 by the end of 2012. By 2015, we expect 22 luxury models to be locally built, which will mean that those models will account for 60% of luxury sales, up from 56% in 2009.

Regulations and Import Duties Advance Localization in China

While the pursuit of profits drives both foreign brands and their local partners to look to localization, a change in regulation on import duties in September 2009 accelerated the process. Before the change, there was no difference in taxes on imported complete vehicles or components for assembly in China. Both had tax rates of 25%. Now, foreign brands continue to pay the same rate of 25% on vehicle imports while those brands importing components pay just 10%.

In the past, foreign brands didn’t have to share profits with their local partners when importing complete vehicles, but now they are being pushed to produce more vehicles at their joint venture (JV) operations with more components either locally sourced or imported to lower the cost. In addition, these foreign brands can lower the risk of exchange rate fluctuations through local sourcing. Consequently, there is now a greater share of profits for local partners. Luxury vehicle makers now see their joint ventures as assembly operations, while these manufacturers still control core functions including: brand strategy, R&D, product lineup and dealer networks.

BMW, Daimler Work with Smaller Local Partners

Luxury brands tend to look for local partners with smaller market shares or weak brand power, who are eager to boost their images through cooperation with foreign automakers.

BMW, for instance, selected Brilliance Auto, while Daimler chose Beijing Automotive Industry Group (BAIC). Both Brilliance and BAIC are less significant players in China’s market and apparently expected the foreign luxury makers to help make their brands stronger. Yet after several years of cooperation, the joint ventures have boomed but the local partners have felt little direct impact. In fact, the joint ventures have become core assets for these local partners as they rely heavily on the profits and technology from the partnerships.

Interestingly, Brilliance Auto peeled off its own Zhonghua car business from its Hong Kong-listed company in 2009 because it had lost money for two consecutive years. The performance of the BMW brand in China then became the indicator for Brilliance Auto’s stock.

Similarly, BAIC considered its joint venture with Daimler a core asset when it was preparing for listing on the A-share market. BAIC’s own car business started operations in 2010, though it has yet to launch any new models. Daimler took control of the JV, and determined the product mix, brand strategy and marketing plan. BAIC, the weaker partner, has had little influence in the JV’s decision-making process.

Land Rover could be next, with its potential partner, Chery. It is most likely that Land Rover will take the lead on branding and technology.

Chinese Government Regulations Intended to Help Local Producers

China’s central government encourages localization, which was intended to include the whole value chain, not just a factory. While local partners may be able to fully participate in the R&D, production and human resource systems, there are very few who do so.

Local makers realize the problem and are trying to strengthen their cooperation with the luxury brands. They understand there is more than just profit, and that know-how and qualified talent are the fundamentals for long-term development.

Local Partners Begin to Focus on Future Growth Rather than Short-Term Profits

Zhonghua Car is often criticized for its narrow product lineup and lack of R&D capability. However, we hear that BMW will transfer the current 3 Series platform to Brilliance after the new-generation model is launched. This could happen in 3 years. Brilliance Auto has been working hard to improve its business. Similarly, we also know that the strategy to develop an independent brand might be used in a Chery and Land Rover partnership, which should help Chery get the technology it needs to grow.

It’s a positive change to see local manufacturers making efforts to further their development as producers, but there are still concerns. Without qualified talent, Zhonghua might find it difficult to make full use of the advanced technology it will be adopting, and may ultimately choose to just duplicate previous products. Technology and talent are like hardware and software—in order for the hardware to be utilized effectively and fruitfully, it needs to be supported by quality software.Jenny Gu, senior analyst, J.D. Power Asia Pacific and LMC Automotive

Note: This post is excerpted from a column in the China Daily newspaper.

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